The world's financial systems are shaking, and trust in the Federal Reserve (Fed) has been on a steady decline since the end of 2021. Notably, criticism from ex-Fed officials over its economic forecasts has been growing, and the global financial markets have largely dismissed the Fed's predictions. However, the erosion extends beyond the Fed to the broader financial systems globally. As we navigate this turbulent economic landscape, long-duration US Treasuries (TLT) offer a unique investment opportunity characterized by high income potential with limited downside risk.
Globally, regulators have accumulated numerous problems over the past two years, largely driven by fiscal and monetary incontinence, populism, and erratic central bank actions. The current challenges facing various financial systems globally include:SourceMoneyGuru-https://www.mgkx.com/4908.html
- The European Central Bank (ECB) is being forced to significantly cut down its bloated balance sheet, potentially triggering liquidity issues for several banks.
- In the UK, extreme populist measures have led to near-collapse of the debt market, threatening pension funds and insurance companies.
- The Bank of Japan is facing inevitable devaluation of the yen due to its aggressive buying of government bonds.
- The Swiss National Bank (SNB) had to step into Fed swaps to save Credit Suisse from a liquidity crisis, which ultimately failed.
- In Turkey, President Erdogan's economic experiment led to rampant inflation, a free-falling lira, and a depleted reserve.
Despite these issues, the world has kept spinning, largely due to sustained liquidity in the system. However, mounting pressure is expected in the coming months as the US Treasury prepares to borrow around $1 trillion. The shift from short to longer-duration debt as part of the standard refinancing process will likely result in a liquidity outflow.SourceMoneyGuru-https://www.mgkx.com/4908.html
Adding to this pressure is the Fed's transmission delay due to the difference between the national deposit rates and the Federal Funds Rate (FFR). The Fed's goal is to increase deposit costs to curb inflation, but this can only be achieved through more aggressive rate hikes than the market expects, followed by a prolonged holding period. The financial system, however, is not built to withstand this approach. The pressure of the Fed's rate hike will increase as the US Treasury withdraws approximately $0.6 trillion from the system by the end of July.SourceMoneyGuru-https://www.mgkx.com/4908.html
Considering the Fed's short-sightedness, I predict a scenario where they tighten their fight against inflation, shaking the system, and ultimately capitulating by lowering rates.SourceMoneyGuru-https://www.mgkx.com/4908.html
In such times of economic uncertainty, it's imperative to have investment instruments that are resilient and offer good returns. Until recently, ProShares UltraShort 20+ Year Treasury ETF (NYSEARCA:TBT) was considered an excellent hedge. However, the market’s disagreement with the Fed's stance and the lack of a direct correlation between stock and bond markets makes TBT less attractive.SourceMoneyGuru-https://www.mgkx.com/4908.html
On the other hand, long-duration bonds, such as the iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT), are typically the quickest to price in expected system shocks. On a horizon of 1-1.5 years, I believe the Fed's conditions make US Treasuries the most potentially lucrative asset, considering adequate risk management.SourceMoneyGuru-https://www.mgkx.com/4908.html
The stock market faces potential liquidity drains and a decline in corporate earnings due to a looming recession. Other investment alternatives like gold and Bitcoin come with their complexities and liquidity issues, while also potentially facing regulatory pressures.SourceMoneyGuru-https://www.mgkx.com/4908.html
In conclusion, the second half of this year will likely see accelerated processes due to liquidity withdrawals and increased pressure from high rates in the system. As these processes unfold worldwide and put the world's backbone institutions at risk, it seems the most logical bet currently is on the Fed's capitulation after the ensuing turmoil in the system. Amid this backdrop, TLT appears to be an investment opportunity with high income potential and limited downside risk.SourceMoneyGuru-https://www.mgkx.com/4908.html SourceMoneyGuru-https://www.mgkx.com/4908.html